SAN CLEMENTE, CA—An agency's failure to justify properly or use development-impact fees could result in the loss of such fees, even several years later, Allen Matkins partner Matthew Fogt tells GlobeSt.com exclusively. The California Court of Appeal recently affirmed the trial court's judgment against the City of San Clemente, which ordered the City to refund approximately $10.5 million in unexpended development-impact fees relating to beach parking that the City assessed against non-coastal residential development since 1989. The refund represents a significant loss of funding for the City and a windfall for thousands of unsuspecting homeowners, according to Fogt.

The takeaways from this case are many, says Fogt. “An agency's failure to follow specific legal requirements with respect to fees could result in the loss of such fee revenue. Courts are not always deferential to agencies, especially when an agency fails to follow clear requirements of the law. Also, an agency must have a well-defined purpose when charging development-impact fees on new development.”

As Fogt explains it, in 1989 the City adopted a “beach parking impact fee” for non-coastal-zone residential development to mitigate anticipated public parking demands at the city's beaches. The City set the beach fee at $1,500 per dwelling unit, which was reduced to $750 per dwelling unit in 1996 because the parking need did not materialize as anticipated.

The City's sole expenditure of funds, other than administrative fees, occurred in 1994, when it used $337,000 to acquire a vacant lot with the intent of using it for public beach parking. The City conducted several studies regarding beach parking in the 1990s and consistently found that the anticipated parking deficiency did not materialize and the existing parking facilities were adequate. However, notwithstanding such findings, the City continued to impose the beach fee and collected nearly $10 million in fees and accrued interest between 1989 and 2009.

Fogt goes on to explain that the Mitigation Fee Act, which governs the imposition and use of development impact fees, requires agencies to make findings every five years to justify the continued retention of unexpended development-impact fees. The five-year findings must identify how the fee will be used, demonstrate a reasonable relationship between the fee and the purpose for which it is charged, identify all sources and amounts of funding anticipated to complete financing for incomplete improvements identified when the fee was established and designate the approximate dates for the funding to be deposited in the dedicated account. If an agency fails to make the five-year findings, the Fee Act requires the refund of unexpended fees.

The City made cursory findings in 2004 and 2009 to justify the continued retention of the beach fees before plaintiffs filed an action in 2012 challenging the continued retention of such fees. The Court refused to address the challenge to the 2004 findings because the four-year statute of limitation had already passed. However, the Court agreed with the plaintiffs that the City's 2009 findings did not comply with the Fee Act, and thus a refund was required.

According to Fogt, the Court noted that the five-year findings requirement in the Fee Act imposes a duty on the City to reexamine the need for the unexpended fees. An agency may not rely on its prior findings used to justify the establishment of the original fee program, but instead must make new findings on each of the four issues noted above. For example, the City failed to discuss the relationship between the $10-million balance and the purpose for which the beach fee was established, let alone demonstrate a reasonable relationship between the unexpended fees and the purpose. Additionally, the City failed to identify exactly how and when it would use the fees, including specific improvements to be constructed and additional funding sources as required by the Fee Act.

The Court also found that the Fee Act clearly and unambiguously requires the refund of unexpended fees and does provide an agency with an opportunity to correct inadequate findings; only provides for the refund of funds and does not require the liquidation of assets unless the asset was improperly acquired or is subsequently improperly used contrary to the intended purpose; and an agency may charge administrative overhead costs associated with the development-impact fee. Fogt says, “The Court's decision will likely lead to additional challenges to unexpended fees throughout California and five-year findings that more closely comply with the four requirements of the Fee Act.”

The bottom line for the real estate industry: city governments need to keep a close eye on fees levied to property owners and/or users and provide the proper proof that these fees are necessary and the funds used appropriately—or suffer the consequences.